Each piece of commercial real estate is distinct and illiquid. If you wish to sell real estate, you’ll have to wait a long time before you can recover your investment and any earnings. Commercial real estate deals often take months, if not years, to complete – never minutes or hours. Illiquidity does increase the risk for sellers arranging a transaction. So, then is it then the end of the world for you? No, because several investment options are available to help you minimize this risk.
Real Estate Liquidity Risk Means?
The liquidity risk is concerned with whether or not the investment can be “cashed out” in the future. Real estate is often seen as an illiquid asset; it is not necessarily easily liquidate.
The potential failure to sell a property fast is a liquidity risk for real estate investors. When selling a property, an investor who wants money right at once will be at a disadvantage. It is not to argue that an investor cannot sell the property. The difficulty is that to get rid of it quickly, the investor will most likely have to sell it for much less than expected. That is called liquidity risk.
Of course, a hot real estate market might alter the picture. However, if the market is not strong, liquidity risk is always present.
Real estate investment entails tying up funds for extended periods. Real estate is not a liquid asset; those who realize this invest only with money that will not be needed shortly.
If the economy is in a slump, finance sources may dry up significantly, limiting the pool of possible purchasers to individuals who do not require traditional financing. As a result, it might be tough to sell a home fast without significantly lowering the price under fair market value.
An Example of Real Estate Liquidity
Let’s imagine you need $5,000 to buy a secondhand automobile as an illustration of liquidity. The finest asset you can utilize to purchase that secondhand automobile is cash.
If you don’t have $5,000 in cash but have a valuable piece of art, you’ll need to locate someone ready to buy the painting for at least $5,000 to afford the automobile.
The art would be regarded as less liquid than cash since it would take some time to locate someone to buy it, delaying your ability to acquire the automobile.
The same holds for your real estate holdings. Assume you wish to buy a car, this time a 1969 Ford Mustang 429 Boss. A private seller is selling it for $300,000 and only accepts cash.
Fortunately, you own an office building that you can sell for around the same sum, plus a little extra to pay your commercial real estate brokers’ expenses. Perfect!
Assume that your commercial space is in worse condition than when you purchased it. It’s also in a former tech hotspot, but since the COVID-19 epidemic, remote work has become the norm, and traditional office space is in short supply.
Your office building now doesn’t appear to get very liquid, does it?
The Role of Liquidity in Commercial Real Estate Markets
The measure of liquidity in commercial real estate value is how soon a property you own will resell at market value.
Because the market is volatile, you may be able to sell a substantial asset, such as our office building in the preceding example, either fast or slowly.
When real estate sells fast and at (or close to) market value, the market is said to be “liquid.” If the market is “illiquid,” your property may sell more slowly and at a price that differs from the market value—either for more or for less.
Several commercial real estate properties, primarily highly specialized properties and “trophy properties” (assume: the real estate equivalent of that Mustang), operate in a relatively illiquid market.
There are generally few purchasers for these highly costly properties, making it difficult to sell homes fast, and sellers sometimes have to settle at a lowered final price if they want to dispose of the property swiftly.
Another major distinction is between a “hot market” and a “cold market.” When the market is hot, it indicates that prices are increasing and people are purchasing. When a market is chilly, it signifies that prices are falling and individuals are less eager to buy.
High liquidity indicates a hot market, whereas low liquidity indicates a cold market.
Investment Strategies to Reduce Real Estate Liquidity Risk
You may begin making real estate investments that are suited for you now that you understand real estate liquidity.
- Fractional Ownership: Investing in commercial property is pricey and requires owning or spending crores. But, the insufficiency of capital should not prevent you from investing. You can invest even with just lacs thanks to fractional ownership. An investor can invest in fractional ownership of commercial space via Assetmonk with only Rs. 25 lacs. Fractional ownership is an investment strategy where a collective of people each owns a piece of property, sharing the costs of maintenance and acquisitions along with the reward. Instead of investing in an entire property and putting up the money, fractional ownership investing enables investors to own a proportionate piece of assets. For novice investors with little market knowledge, fractional ownership offers a minimal ticket size to enter. A fractional ownership investor should start small by investing in luxury residences in major cities. As previously said, real estate has a liquidity problem. So it’s reasonable that you’d rather not invest. But wait a second. If you have already begun investing in real estate, you are not required to withdraw your funds. You can still have hope. How so? To the rescue comes fractional ownership. The liquidity of traditional real estate investments is lower than that of fractional property assets. Of course, you should double-check your contract, but the ability to sell your investment at any time makes trading less dangerous. You can sell and transfer your portion of the property to others if you invest in fractional ownership. Do not miss Fractional Ownership In Indian Real Estate: What Is The Big Picture?
- REITs: REITs or Real estate investment trusts, originated as a solution to real estate illiquidity. These corporations exist to possess commercial real estate and sell stock to investors. This ownership structure enables extraordinary liquidity in the case of publicly listed REITs. A deal can get conducted seconds after an investor clicks a button to purchase or sell shares. A jittery investor can purchase REIT shares after breakfast and sell them after noon. When purchasing and selling properties, the REIT still confronts regular illiquidity difficulties, but for the investor, the liquidity issue is resolved. REITs offer an instrument that allows an illiquid asset to be exchanged easily, and investors who invest in REITs get considered to pay a “liquidity premium.” It is an additional expense they incur over the value of the underlying asset in exchange for the advantage of liquidity for an illiquid asset. Stocks are the most liquid asset. As a result, REITs are extremely liquid. REITs are publicly listed firms that hold or finance real estate. In general, you can purchase and sell REIT shares between 9:30 a.m. and 4:00 p.m., Monday through Friday. REITs have risen in popularity among retail and institutional investors, owing to the good outlook for future commercial space. REITs are tax-advantageous investments in income-producing real estate. Capital appreciation and dividends get used to generate profits. REIT units, like stocks, may get purchased from the NSE and BSE, using trading accounts. Do not miss Exploring REITs. Here Are The 3 REITs Listed In India & How To Invest.
As a seasoned commercial real estate investor, you understand the value of having a broad portfolio. Acknowledging real estate liquidity risk is an important aspect of diversification. There will be instances in your life when you will want finances quickly. But, in the end, a savvy investor is in it for the long run.
Are you eager to begin investing in real estate now that you know it may get readily liquidated? Assetmonk is the most popular website for investing in fractional ownership property. It offers smart real estate investing options such as Growth, Growth Plus, and Yield models to assist you in increasing your investment with a projected IRR of 21% each year. Explore our website today to get started with real estate investment the correct way!
Can the Commercial Real Estate Liquidity Problem Be Resolved? Employ These Investment Strategies FAQs
The inverse of liquidity is illiquidity. When security or other assets cannot be readily and rapidly sold or exchanged for cash without suffering a significant loss in value, it is said to be illiquid.
Transaction costs, demand pressure, inventory risk, and the inability to identify buyers and sellers all contribute to real estate’s illiquidity.